Stocks
Stocks, each unit of which is called a share, represent ownership of a company. Stocks, owned either directly or through a mutual fund or ETF, will likely form the majority of most investor’s portfolios.
What are stocks, shares and equities?
Shares, stocks and equities are terms used to describe units of ownership in one or more companies. The owner, known as a shareholder, will also have the right to part of the company’s earnings if a dividend payment is made, as well as voting rights.
The terms are often used interchangeably in finance, but there are some technical differences between them that can cause confusion. Equity is the term for a total ownership stake in the company after the repayment of any debt, while a share or stock describes a single unit of ownership. The plural term shares usually refers to units of ownership in a specific company, while equities and stocks are terms generally used to refer to portions of ownership multiple companies.
How do shares work?
The buying and selling of shares works in a similar way to a marketplace, where parties negotiate a price at which to exchange an asset. Institutions known as stock exchanges facilitate the exchange of publicly listed shares – this requires a company to have held its initial public offering (IPO).
When you buy shares, you are purchasing the underlying share itself, and seeking to hold it over the long term. If a company grows and its value increases, then the value of its shares will also rise, and you can sell your holding for a profit. In the meantime, you would receive dividends and voters’ rights. However, if the company decreased in value, the share price would also fall, and positions may result in a loss.
Alternatively, if you were to trade shares, you would be speculating on the future value of the asset without taking ownership of it. This is commonly used for more short-term strategies. Although you wouldn’t own the underlying shares, you would be able to short a stock more easily than the traditional means of short-selling. So, you could benefit from a declining share price, not just a rising one.
Why do companies list on the stock market?
The primary reason that companies list their stock is in order to raise capital by tapping into the public equity market by selling their shares to individual investors and institutions. This is an alternate method to gaining capital privately via venture capitalists.
Most companies will list on a domestic exchange. For example, in the United States, most shares are listed on the New York Stock Exchange (NYSE). However, it is becoming increasingly common for companies to have multiple listings to take advantage of foreign investment
How many shares are there in a company?
The minimum number of shares that a company can issue is one – this could be the case when there is only one owner of the entire company. However, there is no universal maximum for how many shares a company will issue, so this can vary from company to company.
The number of available shares can also change over time as companies issue more stock or buy back shares from investors
How much is a share worth?
A share’s worth will vary depending on whether you are looking at its fair value or its market value. The fair value is the intrinsic value of a share based on the company’s fundamentals, while the market value is the amount that individuals are currently willing to pay for the share.
The fair value of a share is often much lower than the market value as the latter is heavily influenced by demand, which does not always reflect a share’s fundamentals. If the demand for a share goes up while the supply remains constant, then the share price will rise as people are willing to pay more.
Why buy shares outright?
Investors buy shares as they are deemed a more successful – albeit riskier – way of generating long-term returns than cash ownership. Over the past 100 years, UK equities have generated average returns of 4.99% a year over and above inflation, meaning that the real value of an investment would have doubled every 13 years.1 So, if you expected inflation to be 2.5% on an ongoing basis, you might expect your returns to be 4.99% more than this – so approximately 7.5%.
Share trading only gives investors the option to go long on a company’s stock – meaning that you would generally only profit if the shares rise in value and that they would lose if they declined in value. However, there is the potential to receive dividend payments even if the company’s share price is falling.
Why trade shares CFDs?
Trading shares via derivative products is becoming increasingly popular because it enables individuals to go short as well as long – giving you the potential to profit from markets that fall in price, not just those that rise. This is because there is no requirement to own the underlying asset.
When you trade shares via leveraged products such as CFDs, you’ll only need to put down a fraction of the required capital, known as margin. This is a huge draw to trading shares, as it means less money is required upfront to gain a full market exposure. While leverage has significant benefits, it also comes with risks.
Risks of buying shares outright
The main risk involved in buying shares is that the company gets into difficulty and goes bankrupt, or that the share price falls to zero. If this happened, you would lose your initial outlay – however with share trading, this is always the most you stand to lose. For example, if you’d invested $1000, the most you could ever lose if the share price fell to $0 is $1000.
For traders, the risk of a short-term decline in share prices can be offset by the popular strategy known as hedging. Alternatively, traders could diversify their holdings by buying or speculating on the price of exchange traded funds (ETFs) – these are baskets of shares that track the underlying market price movements.
Risks of trading shares on leverage
The risks posed by trading share CFDs are significantly different due to leverage. When you trade on margin, both your profits and losses are calculated on the full value of your position, rather than this initial outlay. This means that although you have the possibility of magnifying your profits, you also could magnify your losses.
However, there are tools that traders can use to manage this risk. For example, stop-losses enable traders to define their exit point for trades that move against them, while limit orders will close a trade after the market moves by a certain amount in a traders’ favour.
Also, if you decide to short a share – either traditionally via a broker or with derivative products – you would be open to an unlimited downside potential. As, in theory, there is no limit to how much the share price could rise by.
How to buy shares outright
To buy shares outright, you need to open an account with a share trading provider such as IG. You can choose to either buy a fixed number of shares (say 100 shares), or a fixed value (perhaps $1000 worth of shares). Once you have bought the shares, you own them and will earn from any dividend payments. Once you are ready, you can sell them at a later date.
How to trade shares with CFDs
To speculate on the price of an underlying share, you can use derivative products such as CFDs. Before you start to trade shares, it is important to understand both the benefits of using these products, and the risks associated with them.
